Federal Reserve Chairman Alan Greenspan said yesterday that there is little policymakers can do to slow the growth of the large U.S. trade deficit as long as foreigners remain willing to invest in the United States.
Raising interest rates, cutting the federal budget deficit or adjusting exchange rates, as some policymakers and economists have recommended, would not do much to shrink the nation's current account deficit -- the broadest measure of its trade gap -- Greenspan said in a speech delivered via satellite to a central bank conference in Mexico City.
"A nation's current account balance thus is essentially a market phenomenon that is not readily subject to rebalance by targeting one or more policy variables such as the exchange rate," Greenspan said.
The current account deficit measures the nation's total trade gap, including goods, services and investment flows. The United States consumes more than it produces, and foreign investors finance the difference by buying U.S. stocks, bonds and other assets. The deficit grew to a record $668 billion last year and has continued swelling this year.
Greenspan's remarks come as many government officials and economists are debating what policymakers should do to help reduce the massive trade gap.
Many economists warn that this imbalance might be resolved some day through a painful adjustment process that would involve a steep fall in the dollar and surge in U.S. interest rates, sharply slowing the nation's economy or even triggering a recession. Some have urged the U.S. government to help foster a more gradual, less painful adjustment by reducing its budget deficit. They also recommend that Asian and European governments take steps to boost consumer spending -- including imports of U.S. goods -- in their countries.
The International Monetary Fund has been calling for this type of coordinated approach for some time. In a speech last week, IMF Managing Director Rodrigo de Rato called on the U.S. government for "bold action to reduce the fiscal deficit."
For Asia, where many countries boost exports and discourage imports by holding down the value of their currencies, de Rato recommended "greater exchange rate flexibility and increased domestic demand." As for Europe, he urged a variety of measures aimed at boosting long-term growth, such as reducing the length of jobless benefits and establishing "more flexible labor contracts."
Bush administration officials have been saying global imbalances need to be reduced through methods that enhance economic growth. Treasury Secretary John W. Snow, during his recent trip to China, recommended measures to encourage Chinese consumers to spend more of their income. He also reemphasized the U.S. view about the need for China to allow its currency, the yuan, to rise.
The Treasury Department has also exhorted Europe to change its economic structure to spur more economic growth, partly in the hope that Europeans will buy more U.S. products.
The administration also agrees that the United States has its own part to play, by adhering to Bush's target of cutting the budget deficit to about 2 percent of total U.S. economic output by 2008.
But Greenspan, in contrast, suggested yesterday that policymakers could best help the trade gap shrink smoothly over time by getting government out of the way of the markets.
Rising U.S. trade deficits "cannot persist indefinitely," Greenspan said to a conference marking the 80th anniversary of the Banco de Mexico. "At some point investors will balk" at accumulating ever more U.S. stocks, bonds and other assets, he said.
And when investors do pull back, Greenspan suggested, policymakers should ensure the inevitable trade balance adjustment occurs in a global economy that is as flexible as possible -- in which prices, interest rates and exchange rates can move freely in response to changing demand, in which workers can move freely between jobs, and in which government does not interfere in the economy any more than necessary.
"The more flexible an economy, the greater its ability to self-correct after inevitable, often unanticipated disturbances," Greenspan said, saying that the U.S. economy's flexibility has helped it cope with sharp stock market declines, global financial crises and terrorist attacks in recent years. "Being able to rely on markets to do the heavy lifting of adjustment is an exceptionally valuable policy asset."
Greenspan, who steps down as Fed chairman Jan. 31, did not speak about current U.S. economic conditions or the central bank's plans to continue raising short-term interest rates to keep inflation under control.
But he did sound upbeat, saying "the flexibility of our market-driven economy has allowed us, thus far, to weather reasonably well" the steep rise in energy prices over the past two years. "The consequence of this flexibility has been a far more stable economy."